Granting or withholding consent
WATSON v WATCHFINDER [2017]
Here, the Court looked at whether there was an implied duty on directors not to act unreasonably, capriciously or arbitrarily in deciding whether to give their consent to the exercise of a provision in an option agreement or whether the company’s board had an absolute veto over the exercise of the option.
Facts:
- Three individuals (the “Claimants”) entered into a share option agreement (“Option Agreement”) with Watchfinder (“W”).
- Under the Option Agreement the Claimants were entitled to exercise options to buy a certain number of shares in W. The Option Agreement was actually part of an arrangement under which another company, Adoreum Partners (“AP”), of whom the Claimants were all directors and shareholders, had been engaged by W to provide sales and marketing consultancy services including introducing prospective customers, investors and strategic ‘partners’.
- AP had good contacts with a premier brand company (“R”) who it was hoped might become an investor in W. In the event R decided not to invest although AP did play a part in introducing other investors. Crucially, the Option Agreement made no reference to the services being provided nor to any performance related conditions for the exercise of the option to buy the shares.
- The Claimants wanted to exercise the option and it was common ground that all the formal steps required for them to do so had been fulfilled.
- However, W relied upon Clause 3.1 of the Option Agreement, which provided that the option could only be exercised with the consent of a majority of W’s board of directors (“Board”). The key issue was whether the Board had an unconditional right to veto the exercise of the option.
Decision:
- It was concluded that the Board did not have such a right. Had the Court found otherwise, the ‘option’ was meaningless because the right to purchase shares was entirely within W’s gift.
- The Court decided that there was a duty on the Board to exercise its discretion in a way which was not arbitrary, capricious or irrational. Following the Supreme Court's decision in Braganza v BP Shipping (SC) [2015], it said that this duty required the Board to follow a proper process, to consider all the material points and not to take into account irrelevant considerations. In addition, the duty required the Board not to reach an outcome which was outside what any reasonable decision-maker could decide.
- It was also found that there had not been a proper exercise of the discretion by the Board:
- there seemed to have been very little, if any, discussion and very sparse records kept of the meeting and the decisions taken. The Court felt that this meant the exercise of the discretion had been barely considered at all;
- at the time of the Board meeting, a number of the directors were under the impression (apparently fostered by legal advice) that the Board had an absolute right of veto over the exercise of the option;
- to assess whether there has been compliance with the ‘Braganza’ duty in connection with any particular contractual discretion, it is necessary to know what the decision-maker is meant to be considering when deciding whether or not to exercise discretion. The ambit of the discretion is determined by reference to its apparent purpose. Here the Court decided that the directors should have been reviewing whether the Claimants had overall made a real or significant contribution to the progress or growth of W. By failing to ask themselves this question they were effectively misdirecting themselves.
- Having found that there was a ‘Braganza’ duty and W had failed to comply with it, the Court concluded that the parties should proceed as if consent had been given.
- Accordingly the Claimants succeeded on their claim to require W to proceed with their purchase of its shares under the Option Agreement.
Points to note:
- The outcome of this case would almost certainly have been very different if the Board had gone through a more measured process in deciding whether to consent to the exercise of the option. It highlights the importance of establishing an appropriate documentary trail, showing the range of factors that the directors considered and the process gone through to arrive at that decision.
- This emphasises that where consent is in issue, the party with responsibility for granting or withholding consent must, even where the contract is silent on the point, still act ‘reasonably’ in the sense described.
- A decision such as this, dealing with an express need for consent, does not sit entirely comfortably with cases on exercising a right to terminate which can seemingly be exercised at the party’s sole discretion provided the express conditions are met (see Ilkerler Otomotiv v Perkins Engines (CA) [2017]).
- There was some debate about whether the requirement for consent was supposed to be forward looking ie at the suitability of the individuals concerned as shareholders (akin to a consent to assignment or the suitability of a prospective tenant) or backward looking ie looking at past performance and whether the individuals in question had done enough to justify being allowed to take up their options. This may be something which any contract drafter might, in appropriate circumstances, want to clarify up front.
- It is inappropriate to try to retrospectively justify a decision.